Capitalization ratios, Financial Management

Capitalization ratios are used for determining the extent to which the corporation is trading on its equity, and the resulting financial leverage. These ratios are also referred to as financial leverage ratios. They can be interpreted only in the context of the stability of industry and company earnings and cash flow. It is assumed that if the industry expresses greater stability and company earnings and cash flows, it will be able to accept more risk associated witht the financial leverage.

There are many variants to calculate capitalization ratio. Some of them are- long-term debt to capitalization and total debt to capitalization

Long-term debt to capitalization = (Long-term debt)/ Long-term debt + Shareholders' equity including minority interest

Total debt to capitalization = (Current liabilities + Long-term debt)/Long-term debt + Shareholders' equity including minority interest

Commercial rating companies mostly depend on long-term debt to capitalization ratio. Though this ratio is useful, with the frequent change in interest rates, many corporations are opting to finance a good deal of business with short-term debt. Other consideration in using long-term debt to capitalization ratio involves leased assets. Though obligations on leased assets are similar to that of bond coupon and repayment obligations, they are capitalized and shown in the balance sheet.

Posted Date: 9/10/2012 9:23:40 AM | Location : United States

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